Mechanisms and Processes with Respect to International Trade for Stainless Cookware Ltd - Case Study Example

International Trade Since international trade is much complex in comparison with national or local trade, a certain level of risk is predictable. For buyers, they wonder if they will obtain the proper goods they have ordered and for seller, they wonder after shipping the goods, whether they will be paid. Thus, various mechanisms are required in order to manage these types of risks in a cost-effective manner. Based on this aspect, the report describes various mechanisms and processes with respect to international trade for Stainless Cookware Ltd. Furthermore, the report also provides guidance on documentary aspects which are essential for involving in international trade. Table of Contents Introduction 4 Evaluation of Mechanism of Document against Payment (DP) Collection 4 Suitable Banking Product for Easing Cash Flow for Stainless Cookware 5 Identification of Banking Product for Stainless Cookware to Finance Import 6 Appropriateness of the Incoterm for Stainless Cookware 8 Forward Rates for Forward Exchange Contracts of Stainless Cookware 10 Advantages and Disadvantages of Stainless Cookware for Invoicing in USD 12 Additional Protection for Stainless Cookware Ltd using LC 13 Potential Consequences for Stainless Cookware Ltd in the Event that Mr Gupta is Unable to Present Compliant Documents 14 Conclusion 15 References 16 Introduction A key mechanism for managing international trade is documentary collection. Documentary collection is a procedure where seller instructs the bank to represent documents with respect to the international trade. In this procedure, seller’s bank deals with buyer’s bank for representing or discharging documents to the purchaser against certain terms and conditions. In documentary collection, banks act as an agent for the collection of export and release of documents regarding the goods along with shipping. There are essentially two kinds of documentary collections used for international trade namely ‘documents against acceptance’ (DA) and ‘document against payment’ (DP) (Nedbank Corporate, n.d.). For seller, i.e. Stainless Cookware Ltd, DP is required to be used in order to secure payment for international trade. Evaluation of Mechanism of Document against Payment (DP) Collection In DP, the purchasers can obtain the shipping documents only when they pay the collection amount. Thus, DP can be used as the source for export finance by guaranteeing the earnings as security for bill of exchange. Through the use of DP, Stainless Cookware can keep control of the goods until payment is made by the purchaser, because shipping documents are delivered to the buyer’s bank, rather than the buyer itself. Furthermore, it will also provide an advantage for the purchasers as they can obtain satisfactory amount of time to examine the goods before making payment. There are four parties in DP namely seller, remitting bank, collecting bank and buyer (Nedbank Corporate, n.d.). The roles of each of these parties are described below: Seller: Seller in DP is known as drawer of documentary collection. The seller is supposed to deliver the goods to the purchaser on the basis of sales agreement and submit the documents to the bank with the direction for collection of payment (United Overseas Bank Limited, 2010). Remitting Bank: The remitting bank is regarded as seller’s bank. Its role is to send the documents to the purchaser’s bank with directions for collection of payment. Upon competition of payment from purchaser’s bank, the remitting bank credits the amount to the seller’s bank account (United Overseas Bank Limited, 2010). Collecting Bank: The collecting bank acts as the mediator of the remitting bank in purchaser’s nation. The key role of collecting bank is to forward the documents and collection directions to the buyer’s bank. After collection of payment from the purchaser, the collecting bank pays the amount to the remitting bank after subtracting the necessary charges (United Overseas Bank Limited, 2010). Buyer: Buyer is also regarded as the drawee in documentary collection procedure. The buyer pays for the DP in order to obtain the goods ordered (United Overseas Bank Limited, 2010). Suitable Banking Product for Easing Cash Flow for Stainless Cookware Stainless Cookware can ease cash flow while importing goods to other nations through the use of export factoring. Export factoring is a flexible method of enhancing cash flow for those organisations which are involved in international trade. It discharges cash, which is occupied in international invoices and releases the time consuming and complex activities of pursuing and collecting payments from foreign customers (Jindrichovska, 2007). Export factoring is a complete financial product for Stainless Cookware which combines export working capital funding, credit security, foreign account bookkeeping, and collection of payments. In this product, banks perform financial activities by purchasing invoices. Export factoring works under a contract between factor and exporter, where factor obtains exporter’s temporary foreign receivables and undertakes the risk on the capability of foreign purchaser to pay for goods. The two key advantages Stainless Cookware can gain by using export factoring are the elimination of risk of non-payment by foreign customers and maximisation of cash flow (Intl Business Publications, 2007). In export factoring, the seller signs a contract with the export factor. The export factor then chooses an import factor through worldwide correspondent factor network. The exporter also investigates the credit position of the purchaser while making transaction. Once credit is sanctioned locally, the purchaser places an order for goods. Afterwards, the exporter delivers the goods and provides the invoice to the export factor. Export factor then passes the invoice to import factor who deals with the local collection of payment. Throughout every phase of transaction, records are maintained for the purpose of accounting (Intl Business Publications, 2007). Identification of Banking Product for Stainless Cookware to Finance Import In the simplest form, an importer obviously wants to minimise the risk of international trade by requesting the exporter to document that the products have been delivered. In such circumstance, the bank provides various products for the importer in order to finance the international trade and secure the payment. With respect to Stainless Cookware, Mr Gupta the sole director of the company can use Letter of Credit (LC). LC is a documentary credit which is extensively used in order to make safe payment in national as well as international trade. LC is issued by a bank on request of purchaser, who provides essential directions for the preparation of the documents. LC is regarded as a plan where a bank acts at the request and the direction of the applicant, i.e. importer. Its objective is to make payment to the third party from whom products have been purchased and to receive the bill of exchange drawn by recipient on such transaction. The decision of importer to pay money under a LC is subjected to whether the documents represented in the bank seem according to the terms and conditions of the LC. There are various parties of LC which are described below: Applicant: The first party in LC is applicant who is regarded as the buyer of products and who needs to make payment to the recipient. LC is issued on the request of applicant and according to applicants’ direction (United Overseas Bank Limited, 2010). Issuing Bank: Issuing bank makes the LC and assumes the liability of making payments on the delivery of documents from recipient (United Overseas Bank Limited, 2010). Recipient: Recipient is usually regarded as the seller who will receive payment from applicant on successful delivery of goods. A credit is issued in favour of the recipient, which allows him/her to collect payment from the applicant regarding surrender of stipulated documents and on adherence of terms and conditions of sales agreement (United Overseas Bank Limited, 2010). Advising Bank: Advising bank delivers guidance to recipient and assumes the liability for transferring the documents to the issuing bank (United Overseas Bank Limited, 2010). Confirming Bank: Confirming bank adds assurance to the credit, hence undertakes the liability of payment (United Overseas Bank Limited, 2010). Negotiating Bank: Negotiating bank transfers the document submitted by the recipient under the credit. On transfer of documents, negotiating bank claims the settlement and makes the payment to the recipient according to the terms and conditions of credit (United Overseas Bank Limited, 2010). Reimbursing Bank: Reimbursing bank is allowed to approve the reimbursement claim in clearance of conciliation, receipt and payment lodged by negotiating bank. It is essentially the issuing bank (Export Finance and Insurance Corporation, 2014). There are various LCs that can be used in international trade such as recoverable LC, irrecoverable LC, confirmed LC, and back to back LC among others. For Mr Gupta, irrecoverable LC can be used in order to finance trade. In irrecoverable LC, it is not possible to cancel or modify a credit without contract of the issuing bank, the confirming bank and the recipient. An irrecoverable LC will ensure Mr Gupta that payment will only be made if the required documents are represented and the terms and conditions of the purchase agreement are adhered (FIM Bank, 2011). Appropriateness of the Incoterm for Stainless Cookware Incoterms are regarded as a set of fixed trade rules which are issued by International Chamber of Commerce. Incoterm is extensively used in international trade. The regulations provided by Incoterms are planned mainly to communicate the expenses and risks related with the shipment of products. These regulations are acknowledged internationally in order to interpret commonly used terms. Incoterms minimise the doubts appearing from diverse explanations of regulations in different nations. They are frequently integrated in making sales agreement. With respect to international trade where shipping is entirely undertaken by sea routes, there are four rules devised by Incoterms namely Free alongside Ship (FAS), Free on Board (FOB), Cost and Freight (CFR) and Cost, Insurance and Freight (CIF) (Tetley, 2000). Stainless Cookware has followed FOB in order to conduct international business with a Saudi based company. Under FOB, sellers give payment for shipment of products to the port along with the loading expenses and purchaser pays the freight, insurance and unloading expenses. In FOB, risks arise when products are dispatched at the port of consignment. In FOB, the origin and destination is practiced as convertor, which determines the payment of transportation expenses. In FOB, the purchaser takes the control of products when he/she signs the bill of loading. The purchaser takes the risk of shipping and is permitted to direct the shipment. Furthermore, purchaser is also liable for filling claims for loss or damage of products ordered. On the other hand, in FOB, the seller holds the control of products until they are transported and the sales agreement is fulfilled. The seller can choose the career and is liable for the risk of shipping. The seller is also liable for filling claims for loss or damage of products delivered (dsi-tms, 2014). The general rule of FOB agreement is that purchaser arranges for freight and insurance. Thus, FOB is troublesome for the purchaser, because unlike purchaser, the seller knows the positions to ship the product. However, in FOB, the purchaser possesses the control on the shipping because the purchaser holds the documents of every payment made in the quest of shipping of the goods. On the other hand, FOB also provides advantage to the seller as he can simply recover the goods before it is on board, particularly in case the purchaser defaults in the terms and conditions of selling contract. However, there are certain aspects which are required to be considered by Mr Gupta. First is that Stainless Cookware will have very limited opportunity of recovering the goods after cargo crossed the ship. Moreover, Stainless Cookware also cannot recover the cost of products where the purchaser failed to take the title of the shipment. Stainless Cookware’s right to claim lies only in damages of goods (Zorlu, n.d.). Thus, it is recommended that Stainless Cookware should use CIF method rather than FOB method in order to transport the goods. Unlike FOB, CIF agreements are more attractive. With respect to seller, CIF can deliver an opportunity to increase the revenue by better carriage and insurance provisions. The seller’s profit in CIF agreement is considerably higher in comparison with FOB, because the seller can get a sensible rate for freight and insurance. The seller also holds the right of disposal of goods until the payment is made. Hence. CIF provides better security of payment. Additionally, in CIF, the seller does not bear any risk throughout the transportation of goods. Thus, it can be stated that CIF serves the interest of the seller i.e. Stainless Cookware better. Stainless Cookware can obtain a decisive advantage by charging high cost and considering additional services. Stainless Cookware can obtain the payment before the goods actually reach the purchaser (Asian Logistics Umbrella, 2000). Forward Rates for Forward Exchange Contracts of Stainless Cookware Since the business of Stainless Cookware is related with export and import, it is vulnerable towards exchange rate risk. Thus, Mr Gupta will be required to protect the business against changes in foreign exchange rate. One such method of protection against the risk of foreign exchange is forward contract. Forward contract is a settlement between the seller and the banker where the bank will decide to purchase foreign currency at a fixed rate of exchange during a specified period of time. Forward exchange contracts can facilitate Stainless Cookware to determine the exchange rate which will be applicable for predetermined period of time. In forward exchange contracts, banks typically quote a forward rate for purchasing a specific foreign currency. There are essentially, two types of forward exchange contracts, one is fixed forward exchange contract and the other one is forward option contract. In fixed forward exchange contract, the bank would provide a specific date on which Stainless Cookware will have to pay foreign currency to the bank. On the other hand, in forward option contract, the bank would provide a specific period of time during which it will exchange foreign currency (Export Finance and Insurance Corporation, 2014). In this context, it can be stated that for Stainless Cookware forward option contract will be beneficial for mitigating the risk of foreign exchange. The foreign exchange rate according to 2nd June 2014 is as follows: Spot 1.5201 – 1.5257 Two month forward 0.50c pm – 0.40c pm Three month forward 0.70c pm – 0.50c pm Four month forward 0.90c pm – 0.70c pm Five month forward 1.10c pm – 0.90c pm Six month forward 1.30c pm – 1.10c pm On the basis of above estimations, the forward discount has been calculated below. The forward discount signifies the expected depreciation of British Pound against US Dollars (USD). The two month forward discount is [(0.40-1.52)/1.52]×6=-4.42 The three month forward discount is [(0.50-1.52)/1.52]×4 = -2.68 The four month forward discount is [(0.70-1.52)/1.52]×3=-1.61 The five month forward discount is [(0.90-1.52)/1.52]×2.4=-0.97 The six month forward discount is [(1.10-1.52)/1.52]×2=-0.55 The expected order for the shipment is as follows: Order No 456 Shipped between 1 and 15 August Order No 457 Shipped between 1 and 15 September Order No 458 Shipped between 1 and 15 October Thus, with respect to order number 456, the quoted forward rate will be 2.68% within 2.5 months. For order number 457, the quoted forward rate 1.61% within 3.5 months and for order number 458, the quoted forward rate is 0.97% within 4.5 months. The approximate sterling equivalent for each transaction has been described below: USD 15000 = GBP 8506 USD 17000 = GBP 9747 USD 19500 = GBP 11252 Advantages and Disadvantages of Stainless Cookware for Invoicing in USD An organisation can purchase or sell products in any currency. While purchasing or selling in foreign currency, organisations can use invoice financing method. Invoice financing permits an organisation to exchange invoices into cash directly. It is a popular source of finance for small and medium sized enterprises in the UK. Invoicing can be done through domestic currency or foreign currency. An invoice can be domestic when the transaction currency is similar to base currency, on the other hand, an invoice can be foreign when transaction currency is different than base currency. Through invoicing in USD, Stainless Cookware can obtain the following advantages: Obtain access to instant finance that nurtures with the business Opportunity to subcontract skilled individuals for invoicing with comparatively low expenses Obtain safety against bad debt at preferential rate Acquire finance against stock and other assets at beneficial rate along with terms However, there are certain drawbacks for Stainless Cookware for invoicing in USD, for instance: Foreign invoicing requires extra charges with respect to service charge and interest Invoicing services are disclosed to the customers In certain condition, the quality of credit control provided by the bank can be doubtful Depreciation in exchange rate can bear loss for the company Source: (Small Business UK, 2011) Additional Protection for Stainless Cookware Ltd using LC Conducting business with foreign customers is quite risky because one cannot necessarily know about the parties. The customer can be dishonest and can violate the terms of sales. Furthermore, even if the customer is honest, external business environment such as political unrest can delay the payment of business. There is also a barrier with respect to communication while performing cross-border business. Although LC can be issued in order to secure the terms and conditions of business, LC does not provide protection against inferior quality goods or goods with less quantity. Consequently, it is vital for Stainless Cookware to have proper due vigilance by evaluating the reputation of the party. If the party acts in a deceitful way, the only way available for Stainless Cookware to recover the damage is through legal proceedings. In this context, it can be stated that additional protection to Stainless Cookware can be provided by the bank on requesting extra documentation for making a sales contract. Such documentation comprises certification of inspection, certificate of origin, packing list and weight list among others. These documents can act as an additional security for Stainless Cookware while making international transaction. For example, inspection certificate can ensure that the goods delivered will have appropriate quality (TD Bank Financial Group, n.d.). Potential Consequences for Stainless Cookware Ltd in the Event that Mr Gupta is Unable to Present Compliant Documents Failure to present the compliant documents can lead to penalties for Mr Gupta. There are several levels of penalty which apply to non-compliance of the sales agreement. For instance, there might be a certain amount of penalty imposed on Mr Gupta for failure to represent compliance documents within thirty days. After thirty days, if Mr Gupta still is unable to represent the compliance documents, the second level of penalty can be imposed. In each level, the amount of penalty will be increased for Mr Gupta. In order to resolve the situation, the bank can only notify Mr Gupta regarding the representation of proper compliant documents (Canada Border Service Agency, 2014). Conclusion International trade necessitates various documentations for the purpose of payment along with receiving goods. These documents are intended to deal with the risks, delays in payment or shipment and also prevent any kind of fraudulent intentions from various parties. The report has explained the way in which DP, export factoring and LC among other aspects can be used by Stainless Cookware for proper international transaction. Each of these aspects has their unique role to play in international transaction and also play a crucial role in controlling the activities of parties involved in sales transaction. Furthermore, in order to make international trade successful with minimal risk, Mr Gupta is required to understand the best instruments which satisfy the unique requirements of the business and serve for the best interests for the organisation. References Asian Logistics Umbrella, 2000. Cost, Insurance and Freight. Download. [Online] Available at: http://www.alu-group.com/download/ALU_CIF.pdf [Accessed July 07, 2014]. Canada Border Service Agency, 2014. Master Penalty Document. Trade Commerce. [Online] Available at: http://www.cbsa-asfc.gc.ca/trade-commerce/amps/am-rm-eng.pdf [Accessed July 07, 2014]. dsi-tms, 2014. Shipping Terms of Sale. Portals. [Online] Available at: http://dsi-tms.com/Portals/1987/docs/fob_definition.pdf [Accessed July 07, 2014]. Export Finance and Insurance Corporation, 2014. Documentary Credit. Australian Government. [Online] Available at: http://www.exportfinance.gov.au/Pages/Documentarycredit.aspx#content [Accessed July 07, 2014]. 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